My most recent books are the Leader's Guide to Radical Management (2010), The Leader's Guide to Storytelling (2nd ed, 2011) and The Secret Language of Leadership (2007). I consult with organizations around the world on leadership, innovation, management and business narrative. At the World Bank, I held many management positions, including director of knowledge management (1996-2000). I am currently a director of the Scrum Alliance, an Amazon Affiliate and a fellow of the Lean Software Society. You can follow me on Twitter at @stevedenning. My website is at www.stevedenning.com.

Why The Paradigm Shift In Management Is So Difficult

In 1539, Copernicus overturned more than a thousand years of doctrine that the sun revolves around the earth with his theory that the earth is one of a number of planets revolving around the sun. No amount of tweaking the old theory led to progress. Scientists had to look at the problem in a totally different way to solve the problem.

In 1865, Gregor Mendel presented a paper in Moravia that eventually jettisoned decades of scientific work in genetics. The prevailing theory was that all genetic characteristics were passed from parents to the next generation in an average fashion. Mendel’s work in pea plants showed that genetics works over multiple generations with hybrid, dominant and recessive genes. No amount of tweaking the old theory led to progress. Scientists had to look at the problem in a completely different way to solve the problem.

In 1982, scientists knew that stomach ulcers were caused by stress, spicy foods, and stomach acid. So they ignored Barry Marshall, an Australian physician, when he presented evidence that peptic ulcers are caused by a bacterium living in the stomach. They knew that no bacterium could possibly live in the human stomach, given the presence of acid as strong as that found in a car battery. The breakthrough that won for Marshall the Nobel Prize for Medicine didn’t come by improving the conventional theory of stomach ulcers. He had to look at the problem in a totally different way to solve the problem.

Paradigm shifts are discontinuous

Paradigm shifts are discontinuous. Working ever more diligently within the existing paradigm leads to frustration, not progress. Instead, scientists have to look at the problem in a fundamentally different way to solve the problem.

Now, whether the business schools or managers want it or not, a discontinuous paradigm shift in management is happening. It’s a shift from a firm-centric view of the world in which the firm’s purpose is to make money for its shareholders to a customer-centric view of the world in which the purpose of the firm is to add value for customers.

Among many factors driving the shift is the realization that the new paradigm not only makes more money for the firm than shareholder capitalism: when correctly executed, it makes tons more money, as one can see from the results of firms when they implement the new paradigm, like Apple [AAPL], Amazon [AMZN], Salesforce [CRM], Costco [COST] or Zara [BMAD:ITX]. The fact that it’s also better for those doing the work and for those for whom the work is done will also help accelerate the transition.

The paradigm shift is as fundamental as the shift from a geocentric to a heliocentric view of the heavens, the realization that genes work over multiple generations, or the discovery that stomach ulcers are caused by a bacterium.

The shift in management is a shift from shareholder capitalism in which the firm revolves around the manager to a customer capitalism in which the firm revolves around the customer. No amount of tweaking the shareholder model of capitalism can fix it, because the goal of making money for shareholder entails a set of management practices—hierarchical bureaucracy—that are inherently incompatible with the goal of delighting customers: each tweak entails a new set of problems, that sooner or later lead the firm to regress back to the norm of hierarchical bureaucracy.

Common sense is commonly wrong

One problem that paradigm shifts in science encounter is that the shifts appear to fly in the face of common sense. Copernicus’s theory of a heliocentric world ran flat smack into this problem. It was “obvious” that the sun and the stars revolve around the earth. Use your eyes! Half the stars are above the horizon and half are below the horizon at any given time. Can’t you see? The idea that the solid ground on which we are standing is whizzing through space at 60,000 miles an hour? Preposterous!

Before Barry Marshall, every scientist knew that no bacterium could live in the human stomach, as the stomach produced acid as strong as that found in a car battery. A bacterium in the stomach causing ulcers? Ridiculous!

To many managers today, the idea that the purpose of a firm is to make money for its shareholders is equally obvious. The shareholders created the firm. They own it. They control it. Why would they be doing all this if it wasn’t to make money for themselves? It’s common sense. Everyone knows that.

Everyone, that is, except anyone who has actually set foot into a marketplace and tried to operate on that basis. The commercial reality is that in a marketplace, people won’t part with their money unless they believe that we are offering something to them. They may do business with us once, but if they find out that we are simply out to make money for ourselves at their expense, they will stop doing business with us as soon as they can.

The only vaIid definition of business purpose

This social reality is expressed in Peter Drucker’s dictum of 1973: “There is only one valid definition of business purpose: to create a customer… It is the customer who determines what a business is. It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth…The customer is the foundation of a business and keeps it in existence.”

However, the idea that a firm is in business to make money for its shareholders wasn’t invented by people who had spent time in the marketplace and asked customers to part with their money. It was invented by money men trying to figure out how to get rich from a pre-existing franchise and by academics in back-rooms aiding and abetting their cause. They didn’t notice that if firms devoted themselves to making money, the firm would soon start doing things that got in the way of making money, like making money from bad profits, like seeking quick wins that destroyed the firm’s sustainability, like shying away from innovation as too risky or like encouraging the C-suite to feather its own nests.

“The current paradigm used to work”

Another interesting facet of paradigm shifts in science is that the older paradigm is difficult to displace precisely because it has been shown to work in solving problems in the past. Thus in astronomy, the geocentric system, espoused by the Hellenistic astronomer Claudius Ptolemaeus in the 2nd century AD, was accepted for over a thousand years as the correct cosmological model by European and Islamic astronomers. It offered accurate predictions of celestial events, such as planetary positions. So why replace it?

Copernicus’s heliocentric model did no better than predicting celestial events than the Ptolemaic system. All the Copernicus’s model could offer was the nebulous promise of better, simpler, solutions to other problems, that might be developed at some point in the future.

Fifty years ago, when a few big firms could dictate terms to the marketplace, the idea that the firm could simply focus on making money worked. But as globalization and the Internet steadily shifted the balance of power from the seller to the buyer, firms that simply focused on making money found it steadily more difficult to achieve profitability.

Now what used to be common sense is obsolete. If you want to make money, focus on delivering value to customers. Making money is the result of the firm’s activities, not the goal.

The social cost of replacing paradigms

Copernicus’s theory was a better theory, but the social and political cost of accepting it was horrendous: it risked undermining the entire religious basis of medieval society, along with the authority of the Pope. It wasn’t until several centuries later that the Roman Catholic Church finally capitulated and accepted they theory.

Similarly the shift from a firm-centric view of the world to a customer-centric view of the world has horrendous psychological costs for managers who have perceived themselves as being in control of the workplace and the marketplace. To accept the new paradigm they would have to accept that the customer is the boss. Unthinkable!

Criteria for assessing competing paradigms

Thomas Kuhn suggested criteria to help determine whether a shift in paradigm is warranted. The criteria are:

Accurate – empirically adequate with experimentation and observation

Consistent – internally consistent, but also externally consistent with other theories

Simple – the simplest explanation, principally similar to Occam’s Razor

Broad Scope – a theory’s consequences should extend beyond that which it was initially designed to explain

Fruitful – a theory should disclose new phenomena or new relationships among phenomena

What is fruitful?

Both the geocentric and the heliocentric views of the world were accurate, consistent and simple. Where they differed was in “broad scope” and “fruitfulness”. The geocentric theory offered no explanation why the planets were revolving in these circles and offered no plausible picture of the universe as a whole. The heliocentric theory answered these questions and suggested a whole range of useful hypotheses about the rest of the universe. As a result, it triumphed, despite the social cost to earthly authority.

Similarly the firm-centric view of the world and customer-centric view of the world are both simple and internally consistent. Where they differ most is in terms of accuracy and fruitfulness.

In terms of accuracy, the firm-centric view of the world offers no explanation why the rates of return on assets and on invested capital have been in decline for more than four decades and no suggests no way forward in an economy where there is low demand for the foreseeable future.

In terms of “fruitfulness” of management, the dimensions are whether the shift is (1) good for the firm and its shareholders, (2) good for those doing the work, (3) good for those for whom the work is done and (4) good for other stakeholders in the community and society in which the firm operates.

Much of the writing about reforming management over the last century has focused either on (2) what is good for those doing the work, or (3) what is good for those for whom the work is done or (4) what is good for the society in which the firm operates.

However the decisive advantage for the customer-focused view of the firm is that it is better for the firm itself i.e. makes more money for the firm and its shareholders. The other elements of fruitfulness are nice. What makes the paradigm shift inexorable is the fact that it makes more money.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

Steve, I enjoyed your perspective. I still think the most radical management approach would be to dive into the engagement and exaltation of human capital in every way possible. There simply is no better brand ambassador than a happy and productive worker who feels valued.

You write: “I still think the most radical management approach would be to dive into the engagement and exaltation of human capital in every way possible.”

I agree, provided, and it’s a big provided, that “the happy and productive worker who feels valued” is focused on delivering value to customers and is actually perceived by the customer to be delivering that value.

Sadly, the startup world is littered with the remains of many, many companies that were once full of happy and productive workers producing stuff that, alas, not enough customers wanted.

So the goal is “delighting the customer”. The “happy and productive worker who feels valued” is the means. Both are needed. One without the other is disaster.

Customer-Centric – A great topic. I tend to be quite the sales magnet, though I tend to not be a hunter & gatherer salesperson. Often, people confuse the two and get frustrated as they want to hire me to be something different than I am. I focus on the work and relationship – the rest follows (well, there is more to it, though you get the point) – and the track record historically has been overwhelming success. Customer-Centric approaches are not new – they are just not the one size fits all approaches and certainly take much more effort – all be it effort well worth taking then and now.

My first position following law school was doing a bank merger and one of the “troubled loans” was a paper products distribution company. Let’s just say the bank had serious concern from the balance sheet perspective, though they were never late on a payment and it did not take too long to figure out they had the “whose who” of clientele (and all seemed to “love” them) – and maybe they really did have potential. Well, I kept them around and 19 years later they are still in business, larger than ever, a solid employee base, an even more impressive client base, and …. Interestingly, they have since day one had serious price competition and their prices have never been the best, though their service is incredible.

I worked as both a research scientist, and a marketer and I’m not sure that I agree that it is a paradigm shift we are seeing. The shareholders are still the owners, and they wield ultimate authority and power over the organization. Maybe the difference is semantic, but it seems that you are describing a change in business strategy and/or management tactics. The goal remains to maximize shareholder value.

I do think the B corporation represents a paradigm shift, because the corporation is structured in such a way that a social benefit as well as profit are codified as objectives of the company.

I think another key difference is short term vs long term shareholder value. Short term value does not maximize customer value, whereas long term value does.

You write: “The shareholders are still the owners, and they wield ultimate authority and power over the organization.” This sounds grand but I am afraid it is largely mythology: in today’s business world, the only control available to almost all shareholders is to sell their shares. The mythology is however convenient cover for the over-compensated C-suite who can say: we are just doing the will of the shareholders.

It’s true that the *result* of a well-managed company is to make money for the shareholders. But if that becomes the *goal* of those who are managing, then it focuses attention on the wrong things and leads to the firm doing things that get in the way of making money, like making money from bad profits, seeking quick wins that destroy the firm’s sustainability, shying away from innovation as too risky or encouraging the C-suite to feather its own nests.

That’s why maximizing short-term shareholder value as a goal is, as Jack Welch said, “the dumbest idea in the world”. Trying to salvage something from the conceptual wreckage by saying, “let’s focus on long-term shareholder value” doesn’t work either as a way of running the company. That’s because the best proxy for long-term shareholder value is short-term shareholder value. You can tell middle managers to focus on long term shareholder value but they will translate that into: what makes money for the quarter? Plus ca change, plus c’est la meme chose.

So I believe this is a different mental model of the world–a different management paradigm. Those managers who don’t “get it” will continue to face the problem of declining ROA and ROIC–working harder and harder for less and less return–until they do get it. It helps us understand why the members of the C-suite are so keen to cash in their chips as quickly as possible and leave.

I have continued to think about this issue today, and went through the archives of my blog book, and lo and behold I have written on the issue.

While it is true that individual shareholders don’t have a lot of influence, the institutional investors probably have more influence today than they ever have. To quote myself quoting The Loyalty Effect by Frederick Reichheld: “The average public company in the United States now suffers investor churn of more than 50% per year.” In other words, half of a companies stock will be bought and sold in less than 12 months, and those owners only care about short term results since they will not be owners a year from now. This translates into short term decisions like cutting R&D spending to make the balance sheet look better.

I agree this is a poor business strategy in the long term, but it is a headwind at some companies. If you are interested, the full post is here.

I agree that institutional shareholders could be, and should be, advocates for change and part of the eventual solution, as I argued here: http://www.forbes.com/sites/stevedenning/2012/02/22/hbr-blows-the-lid-off-c-suite-over-compensation/

However as I also noted there, institutional investors have often swallowed the same Kool-Aid of shareholder value, are often chasing short-term returns in the belief that this is the path to long-term returns, and have increasingly put their faith in false promises of get-rich-quick schemes like private equity. Many pension funds are now hiding their own insolvency as a result of having followed these tactics, and hence are unlikely to be vocal spokespersons for change, at least until they can get their own houses in order. In the artificially-low interest regime of today, orchestrated by the Fed, this isn’t going to be any time soon.